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Traditional vs. Roth IRA

Traditional vs. Roth IRA

April 17, 2024

 Which is the right investment account type for you: Traditional or Roth IRA?

 What a great topic to cover as we have just finished the official tax season. So often I am asked whether to own and/or contribute to a Traditional (or “regular” or “rollover”) IRA versus a Roth IRA. First, let’s review the difference between a Traditional IRA and a Roth IRA.

A traditional IRA is considered a pre-tax investment account; that is, every dollar contributed to this IRA is tax-deductible on the owner’s 1040 return in that tax year. Withdrawals after age 59 ½ are penalty-free but are considered taxable income. If you pass away, your beneficiaries must pay the tax as they make withdrawals.

Roth IRAs are considered post-tax investment accounts. Contributions are not tax-deductible but withdrawals are tax-free income after age 59 ½ and provided that the contributions have been in the Roth IRA for at least five years. Roth IRAs remain tax-free income to your beneficiaries if these accounts become inherited.

Which is right for you?

Well, there are many factors to consider. If your tax bracket during your working years is relatively low, a RothIRA is potentially advantageous because of the lack of need for tax deductions. Roth IRAs can be an attractive investment supplement to a 401(k) as well. Contributing to a traditional IRA typically indicates that you have earned income but no access to a company sponsored retirement plan such as a 401(k) or SIMPLE IRA.

I have a pre-tax 401(k) or 403(b) and wish to rollover to an IRA at retirement. Should I choose a traditional IRA or Roth for the rollover?

This is another popular question. Rolling over your pre-tax 401(k) to a traditional pre-tax IRA is the most common selection because the transaction is not taxable. Only when you begin withdrawals from the new traditional IRA are you subject to federal and possibly state income taxes. Rolling over your pre-tax 401(k) to a post-tax Roth IRA would make the entire transaction taxable at the time of transfer. Choosing this option requires much consideration and consultation with your accountant as well given the potentially large tax bill in that year.

Many traditional IRA owners also consider converting pre-tax traditional IRAs to post-tax Roth IRAs. This would make the conversion amount taxable in that year. I’m happy to discuss this option with you and your accountant to determine if a conversion is advantageous for your tax situation.

Traditional and Roth IRAs both bring potentially much value to investors. Both have contribution and income limits to consider. Individuals with earned income can contribute up to $7,000 (or $8,000 for those age 50 or older) for traditional and Roth IRAs. (Further rules apply.)

Please contact me to discuss traditional IRAs, Roth IRAs, and employer plans such as 401(k)'s and 403(b)'s in more detail.